US Debt: Made in China?

It’s been well known for some time now: China is a major lender to the United States. Or, said another way, the US is hugely indebted to China. Sounds vaguely ominous. After all, if you “owe” someone, they could seemingly come to collect at any time. And if they do, and you can’t pay, then what?

Then, too, it’s not uncommon for folks to glean negative connotations from the concept of “debt.” For many folks, it’s as much a moral issue as anything—predicated primarily on the understanding if you can’t outright “afford” something, you just shouldn’t buy it. You should save your pennies until it’s financially attainable, and then you can buy it. And there’s nothing wrong with that view!

But we’d argue there’s equally a case to be made folks who work hard, have clean credit, have built a reasonable personal reserve of savings—whether of the liquid or illiquid type—should be able to use that creditworthiness to borrow money. In fact, we’d argue it’s one of capitalism’s greatest inventions—allowing those with sufficient capital reserves to make (in their estimation) reasonable bets on those who maybe have a great investment or business idea (or or or) but insufficient capital to initiate it. Those bets, throughout history, have created inestimable global wealth—and overall and on average, have more often than not been profitable for all parties involved. If they hadn’t been, no doubt we’d have long since seen the death of credit practices as we know them.

But the notion we’re somehow “indebted” to China strikes us as rather odd. What folks are commonly referring to is the amount of US Treasurys held by China. And it’s true Treasurys are a debt instrument—meaning they’re a liability on the US’s balance sheet and an asset on the owner’s. But let’s be clear: No one’s holding a gun to China’s head and forcing it to “lend” the US money (i.e., buy US Treasurys). In fact, it’s important to remember in nearly any transaction conducted in a relatively free market, both parties to the transaction must stand in some way to benefit from it—otherwise, why would they conduct the transaction in the first place?

So what does China gain from buying US debt? Well, for one thing, it gains access to the largest, most liquid credit market in the world. China has also, to varying degrees, pegged the yuan to the US dollar (though they loosened that some in 2010), and the country needs sufficient dollar-denominated reserves to maintain that peg. And they want those reserves super-safe—an especially sensitive point in many parts of Asia, given the currency crises in 1997-1998. If their reserves aren’t safe, they run the risk they can’t as smoothly maintain their currency peg—and what’s safer than US Treasurys?

Even if China were to move away from a currency peg altogether, chances are they’d do so quite gradually, meaning we likely wouldn’t see some enormous glut of US Treasurys available for sale on the market. Then, too, consider holding US debt isn’t quite like a bank’s holding a loan for an individual customer, which it could theoretically call at any time. On the contrary—if China were to “call” the US on its debt holdings, what that likely looks like is actually China’s selling some or all of its US Treasury holdings. Which would imply someone else would buy those Treasurys, and since a Treasury’s stated interest rate (coupon) is fixed, that bond changing hands would affect nothing for the US government.

Now, to be sure, a sudden increase in the supply of Treasurys available for sale could shake global investors’ confidence in the US’s overall financial soundness, which could be an overall negative for the US. But consider this: In unloading all, or even a significant portion, of its debt holdings at once, China would most likely drive US Treasury prices down—resulting in pretty significant losses on the rest of its Treasury holdings. That wouldn’t make much sense from China’s perspective.

All that aside, though, it’s critical to remember the facts about US Treasury holdings—a significant one being the largest holder of US Treasurys is ... US domestic investors! Who hold some 36% of total US federal debt. The US federal government holds about 30%, and foreign owners hold roughly one third of total US federal debt. Breaking the foreign owners down, China holds roughly 7.4%, Japan holds 7.0%, the UK holds about 1.0%, and 17.9% is held by other countries. Then add in the fact there are indications China’s actually reduced its holdings lately. In that context, the notion we’re overly indebted to China increasingly reads as a rather typical, hyperbolic headline that to an extent twists the reality into an enticingly titillating story.

Now, don’t count on politicians to tell the actual story anytime soon—particularly while there are elections to be won (and lost). But do remember to take a step back from the histrionics and consider the facts before coming to a conclusion about US debt—quite often, the facts just don’t much match the headlines.